This week brought some important developments in the crowdfunding industry that we all should take the time to understand and pay attention to. The Financial Industry Regulatory Authority (FINRA) fined two crowdfunding platforms, WeFunder and StartEngine, a total of $1.75 million for violating FINRA rules.
This news is understandably concerning. But after spending this week reading the news and understanding the rationale behind the regulation, it’s clear this move is a step in the right direction for crowdfunding in the United States.
Here are the three reasons why…
Crowdfunding’s Growing Pains
Crowdfunding is still a young industry. As an asset class, it’s grown explosively in the past few years.
In 2018, the total amount of crowdfunding funds startups raised was $84 million. In 2021, it was $400 million!
Whenever a new asset class starts to form and grow rapidly, there are always growing pains involved with developing best practices, enforcing them, and weeding out bad actors.
U.S. regulatory action like we saw this week is part and parcel of the early days of any asset class.
Compare it to the world of crypto. Over the last decade, the crypto industry grew enormously. For most of the industry, very few regulations exist and the SEC has been working in overdrive to create regulatory frameworks for all the different activities in crypto. They do this to protect not only consumers and investors, but businesses themselves.
The SEC is also working hard to enforce the new standards. There have been 300 active or settled cases involving the crypto industry since 2013. In one particularly high-profile case, the SEC fined crypto platform Blockfi a mammoth $100 million for violating the registration provisions of the Investment Company Act of 1940.
It’s not just new asset classes that are seeing regulatory shifts and enforcement. Another example is the new regulations the SEC has proposed on short-selling institutional investors that was spurred by the infamous GameStop short saga last year (watch this CNBC video if you don’t remember!).
Unlike crowdfunding and crypto, the short-selling industry is not new at all.
Whether they’re growing pains or otherwise, regulations are dynamic and always change to reflect new realities and new thinking. This is as it should be.
US Regulators Protecting Your Interests
The growing pains the crowdfunding industry is experiencing and the regulatory action we’re seeing leads to a second important point: U.S. financial regulators are doing their job to protect your interests as an investor.
In fact, the About page on the FINRA website describes the agency’s purpose as “protecting investors and safeguarding market integrity in a manner that facilitates vibrant capital markets.”
In a statement related to their recent actions Jessica Hopper, Executive Vice President and Head of FINRA’s Department of Enforcement said:
“Today’s actions highlight FINRA’s vigilance over this developing area of securities regulation and our unrelenting focus on investor protection.”
As an investor, having regulators that are progressive enough to encourage innovation in asset classes yet vigilant enough to protect your interests is critical. It’s was enables us to be confident when investing in a new asset class.
FINRA’s actions are a sign that they’re working hard to enable crowdfunding to develop into a healthy new avenue to growing your wealth.
Diligencing Crowdfunding Platforms
The news this week also makes it clear that as an angel investor it’s important not only to do your due diligence on the startup you want to invest in… but to do the same for the specific crowdfunding platform you’re investing through.
Investing is never without risk. But one of the risks you can meaningfully reduce is that related to the platform.
A good place to start is the FINRA website, which lists all the crowdfunding platforms they currently regulate. If the crowdfunding platform you’re thinking of using is not listed there, it’s a sign that FINRA’s watchful eye is not ensuring they comply to the highest standard of the law.
You can also check up on the crowdfunding platforms’ management team with a quick LinkedIn search. Do the founders and senior management have experience from leading companies? Do they have qualifications or past experience working as investors?
In particular, you want to look at the Chief Legal Officers and Head of Compliance at these companies. Do they have strong backgrounds at great law firms? Are they former regulators themselves?
Finally, take a look at the press around a crowdfunding platform and its social media presence. Unhappy investors and startups are hard to hide.
Overall, the FINRA news this week is an important milestone in crowdfunding’s development and every angel investor needs to spend time understanding why they took the actions they did.
In the end, this is positive news for the industry as a whole. Frankly, I’m glad that FINRA is being proactive in guiding crowdfunding’s development and in protecting investor interests.
All the crowdfunding platforms in the space are going to learn from this action and improve their processes and platforms as a result.
In the end, this benefits us all.
Until next week,